Marc Faber: Sit Still, This Is Going to Hurt

Friday was the final day of the 11th annual Agora Financial Investment Symposium in Vancouver, British Columbia, put on by the folks at the Daily Reckoning newsletter. They saved the big guns for last, with Marc Faber -- editor of the Gloom Boom and Doom report, nightmare inducer, and frequent CNBC guest -- giving the day's big speech. Below is a partial transcript of his presentation, edited for clarity.

On reality: My views are not all that negative. I think they're just realistic. I want to face reality. You have people like Paul Krugman who thinks we should have another bubble to pull us out of this. He actually said that. But he said the same thing in 2001. And you know how that turned out.

On unintended consequences: The Fed doesn't seem to have learned anything at all from its mistakes. Their current policy of cutting rates to zero is designed to create sustainable growth, but they've created larger and larger volatility in markets. There are many unintended consequences of their actions.

The oil bubble of 2008 is a good example. In 2008, the price of oil went ballistic, but the U.S. was already in a recession [it began in Dec. 2007]. There was no rational reason oil should have gone ballistic. The Fed's easy money just fueled a bubble. It was like a $500 billion tax on consumers courtesy of the Fed. That's the added amount that it cost you, and it helped push consumers over a cliff in late 2008.

On the Fed: The Fed doesn't pay any attention to asset bubbles when they grow. That's their official policy. But they flood the system with cash when bubbles burst. They only care about bubbles when they crash. It's a very asymmetric response and it has many unintended consequences.

Letting bubbles inflate and then fighting them when they burst actually worked for a while. That's what makes it dangerous. It worked in the '90s. But you shouldn't read too much into this: This period was assisted by unusually favorable conditions. From 1981 until early last decade, commodities were in a bear market after a bubble in the '70s and early '80s. And interest rates were falling throughout the '80s and '90s, too. They almost never stopped falling. That made Fed policy look like it was working.

Bubbles can still happen without expansionary monetary policy. In the 19th century, you had bubbles in railroads, for example. But today, the Fed has created a bubble in everything -- in every single asset class. This is an achievement even for a central bank. Stocks. Commodities. Bonds. Real estate. Gold. Everything goes up when the Fed prints. The only asset that goes down is the U.S. dollar.

On deflation: I'm a believer that the stock market lows of March 2009 will not be revisited. You have people like Robert Prechter who think the Dow will collapse to 700 because of debt deleveraging. Debt deleveraging could happen, but the Dow will not fall because of monetary policy. The Fed will keep everything inflated in nominal terms. And if the Dow does go to 700, you'll have more to worry about than your investments. All the banks will be bust. The government will be bust. You don't want cash if massive deflation happens. On the contrary: It will be worthless. You have to think very carefully about hardcore deflation.

On credit addiction: In a credit-addicted economy, you don't need credit to actually fall for there to be problems. All you need is a slowdown in the growth rate, and you get big problems. Now, the government and the Fed are aware of this, so they are creating debt through fiscal deficits and monetization. That creates a hugely volatile environment. In 2008, government credit creation was inferior to private credit contraction, and asset markets tanked. In 2009, government credit creation was higher than private contraction, and asset markets went ballistic. Lately, government credit creation has slowed, and asset markets have gone down. Now, the Fed is aware of this, and it's only a matter of time before it throws more money into the system. I guarantee this.

On what the Fed will do from here on out: The easiest way to fix our debt problems is with 6% inflation per year. That bails out everyone in debt. Interest rates will stay at 0% in real terms forever, in my opinion. If inflation is 5% per year, the Fed will keep interest rates at 5%; that's how you get 0% real interest rates. Now, we could have debt contraction in the private sector, but it doesn't matter. It will be more than an offset with government debt creation. So it's not a good idea to be all in cash and out of stocks. Cash is very dangerous when central banks want real interest rates at 0%.

On the rest of the world: The U.S. today is much worse off than it was 10 or 20 years ago compared with the rest of the world. The Asians should thank the Federal Reserve for this. The Fed practically created the emerging market economies. The Chinese pegged its currency to the dollar in 1994, and until 1998 not much happened. When the Fed began printing and boosting asset prices in 1998, there was this huge debt growth, and U.S. consumers began spending at a massive rate. That increased our trade deficit from $200 billion to $800 billion. Of course, trade deficits have to be offset by trade surpluses in other countries. So the Chinese began ratcheting up production. Then their employment went up. Their wages went up. Entrepreneurs began investing more money in capital spending. The Fed is not the only factor that led to strong emerging market growth, but it certainly was a major factor in it.

On delusions of grandeur: In the U.S., we still think that we are the largest consumer market in the world. For some services we are, but in general this is the wrong way to look at things.

There are huge differences in how statistics between countries are produced. For one, the U.S. is the most leveraged. Other countries factor this in. Also, consumption in the U.S. is 70% of GDP, but it's almost all on domestic services. Spending on actual goods is only 20% of consumption. In the U.S., we spend $600 billion a year on defense. But $300 billion of this goes to personnel and retiree costs. In China, the cost of personnel is basically nothing. When you adjust for purchasing power, China probably spends about what the U.S. does on military capital.

We also think that we have all the knowledge of the world. We think that's our edge. But knowledge in countries with much larger populations have the edge. Research now is being done in Asia because it's cheaper there. Companies like Intel (Nasdaq: INTC) , IBM (Nasdaq: IBM) , and Microsoft (Nasdaq: MSFT) are researching in Asia. It's just so much cheaper there. And they are smarter than the U.S. in many ways, too. [More students studying engineering, etc.]

Final sobering words: We've had a trend for most of the past 200 years: GDP of countries like China and India went down while the West surged. That's now changed. Emerging economies will go up, and your children in the West will have a lower standard of living than you did. Absolutely. We won't sink to the bottom of the sea. But other countries will grow much faster than us. The world is very competitive, and the odds are stacked against us. Americans, with their inborn arrogance, will not let it go that easily, so there will be lots of tension going forward.

Comments from our Foolish Readers

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I think TMF should have provided just slightly more of a disclaimer to this long quotation, lest Faber be confused for a genuine Fool.

And the notion that the Fed causes instant bubbles across asset classes is misleading at best. Obviously a larger money supply increases demand broadly, but never in just one area. Fed policy can't be blamed for the housing bubble, nor can choosing a couple of years at random from the stock charts prove a causal relationship between government policy and stock market behavior. (Not to mention Faber's casual yet egregious mistake of assuming the Fed and the U.S. government work hand in hand; fiscal and monetary policy are quite different.)

And the notion that the Fed is responsible for rising gold prices is ridiculous. Let's give some credit to the speculators, the bears, the paranoids, the opportunists, and the wingnuts: There are plenty of reasons for gold's rise, the Fed being low on the list.

Finally, you should take with a grain of salt the advice of any person who finds it necessary to pepper his speech with adjectives like "ballistic"--that person is usually overdramatizing or else simply catering to an audience. Regardless, it would be nice to have a further disclaimer, just to know The Fool doesn't stand shoulder-to-shoulder with him.

mistercube, I hope your not putting off the fact that the Fed provided a breeding ground for "credit gurus" during the early and mid 2000's. the Fed kept interest rates low for too long, bringing light to dangerous lending and borrowing practices. with interest rates low in a country filled with speculators, there was bound to be an asset bubble in a market, any market. all it takes is opportunities where an investor can make quick money buy borrowing to turn around and take leveraged risks yielding high returns. it can happen in any market; this time it happened in the real estate market. the fact is that this country needs to deleverage, and start from the bottom up, working on steady but SUSTAINABLE growth. keeping interest rates low for too long creates a speculative environment that encourages risk taking and most importantly, unsustainable growth.

asset bubbles go back all the way to medieval times, when the first reported asset bubble was spurred by tulip bulbs (yes, tulips, the flower). it is not easy to predict asset bubbles, and it is not easy to predict what environment will encourage asset bubbles. not even our former genius Fed chairman, Alan Greenspan could do it. but you could even make the argument that interest rates are too low right now (which i might), but no one truly knows. the safest path to take is to discourage risky borrowing in our economy by lifting interest rates. you may think this is a radical move that could destroy our credit driven economy if implemented right now. but if so, why don't we consider radical moves made by our long-time former Fed chairman Paul Volcker. he made monetary policy moves that were against the grain back in the early 80's... but they worked! maybe something radical needs to be done with our economy today (cough, mainly our fiscal policy, cough). just a thought.

the fact is that with speculative investors in this country and a growing number of speculative investors in other countries around the globe, you can expect to experience more asset bubbles in the future, whether market devastating or not.

An independent and thorough audit of the Fed should be a major priority for the American people. This institution has the ability to effect our economy so profoundly I can not understand why we don't demand more transparency. If the result of the audit sent the economy into a tailspin, it's probably better to learn the truth now than later so that we can start fixing it.

In my humble opinion the Fed has grown in power way beyond its original scope, and with the new power its recently being given, it's only getting worse. I'm not saying abolish the Fed, i'm saying make it do its job and nothing more.

I am jealous you got to attend all these fascinating talks, Morgan! Is there any place on this website where common groups of articles are collected? I.E. All transcripts from Agora, all eleven o clocks, etc. Would be easier to follow with RSS or a dedicated main page or something.

At the top of this page, you can go to Home => All Fool Headlines. That shows all the articles The Motley Fool publishes in chronological order. Also, by each author's name should be a tab that reads "More Articles." That shows articles published by each particular writer.

Not to mention that extremely low interest rates do nothing to encourage people to put their money in savings accounts, CD's, money markets or other cash vehicles. Its a small point, but one that I think deserves mentioning. There is absolutely no incentive for people to keep their portfolio in cash with such a ridiculously low interest rate. How can the government encourage people to save, save, save and all at the same time give them absolutely no reason to save?